Iron ore slump to hit BHP, Rio earnings: Citi

Citi analysts have downgraded their recommendations for BHP and Rio from buy to neutral, with share price targets falling from $39 to $38 and $80 to $74 respectively. Photo: Reuters
AFR

by
Jared Lynch

A plunge in the price of iron ore has prompted Citi to downgrade its earnings expectations for
BHP Billiton
and
Rio Tinto
this year.

The investment bank has joined Goldman Sachs in tipping the price of iron ore – Australia’s most lucrative export – to crash to $US80 a tonne within the next two years.

Citi analysts led by Clarke Wilkins downgraded their recommendations for BHP and Rio from buy to neutral, with share price targets falling from $39 to $38 and $80 to $74 respectively.

Mr Wilkins forecast a 9 per cent fade in Rio’s earnings from 2014 to 2016, saying the lower iron ore prices would offset increased production and cost cuts.

“Iron ore is the dominant earnings driver for the sector and [the] only positive ray of light is that $US80 a tonne iron ore has already been priced in, and/or multiples re-rate as long the expected decline finally happens," Mr Wilkins said in a note to investors.

Fortescue Metals
was also downgraded to neutral; Citi’s price target for the stock fell from $6.70 to $5.90.

Meanwhile,
Atlas Iron
was downgraded to sell while the same recommendation was maintained for
Mount Gibson
. “Atlas continues to extend the life of the trucking model through exploration success," Mr Wilkins said. “But our concerns over its ability to fund the next stage of growth become even greater at lower iron ore prices."

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Atlas posted a $61.1 million underlying half-year profit last week, with the result buoyed by a 50 per cent rise in production volumes compared with the same period in 2013.

Continued slide then ‘modest rebound’

Citi is forecasting iron ore to slip $US7 to $US113 a tonne this year, sliding to $US90 in 2015 and $US80 in 2016, before having a “modest rebound".

Mr Wilkins said the main driver for Citi’s downgrade in the price of iron ore was producers flooding the market and “resilient" Chinese domestic production. “As with other commodities that have tipped into surplus, we expect the price to fall deeper into the cost curve than the market expects.

“Short term, we expect rising Chinese steel production rates and inventory draw down to buoy iron ore prices and stocks, but ultimately both get dragged down by the overwhelming increase in iron ore supply."

Mr Wilkins said Indian iron ore exports, which nosedived from 100 million tonnes to 15 million tonnes in 2013, were expected to recover, adding further pressure to prices.

He tipped exports from the subcontinent to rise 40 million tonnes in 2014 and by 50 million in 2016.

Chinese scrap supply is also likely to accelerate until the end of the decade as metal that was consumed in the early 2000s is recycled, Mr Wilkins said.

“The result is that not only is Chinese steel production growth slowing, but the share supplied by iron ore is also likely to decline."

Iron ore fell below $US120 a tonne last week for the first time since July last year, taking this year’s sell-off to more than 10 per cent. It had defied analyst expectations in the second half of 2013. After falling as low as $US110.40 a tonne, the bulk commodity rose just under 30 per cent.

ANZ was more bullish in its expectations for iron ore, forecasting a 2014 average price of $US123 a tonne.